jpm cap intro 2011

8/4/2019 JPM Cap Intro 2011

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2011 Investor Sentiment ReportRegeneration: Entering a Period o Sustainable Growth


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This report is published by J.P. Morgan Prime Brokerage

For further information, please contact:

Chris Kapsaroff, Global Equities Client Strategy

[email protected]

212 272 1740

Louis Lebedin, Global Co-Head of Prime Brokerage

[email protected]

212 272 8582

Andrea Angelone, Global Co-Head of Prime Brokerage

[email protected]

44 207 779 2647


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Table o Contents

Executive Summary 1

Itroductio Letter 3

Overview: From Retrechmet to Sustaiable Growth 4

I. The Case or Hedge Fuds (ad Istitutioal Capital) 6Investor Allocations in 2011

Hedge Fund Perormance, Cumulative and Risk-Adjusted

The Increasing Importance o Hedge Funds or PensionsInvestment Priorities

II. Regeeratio 9Three-Phased Cycle

Hedge Fund Net Asset Flows

Institutional Investors Making the Largest Allocations Ever

Cash Positions, Redemptions and Investment Durations

Investor Exposure by Strategy

III. Proceedig with Cautio 13Fund o Funds and Consultants - Blurring the Lines

Investment Priorities

Track Record

Increased Due Diligence

Greater Liquidity and Risk Transparency

Interest in UCITS and Managed Accounts

IV. Balace o Power 20Shiting o Power between Investors and Managers

Renegotiations and Redemptions

V. Lookig Ahead 22

Overview o the J.P. Morga CIG: Istitutioal Ivestor Survey, 2011 23


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2011 InVESTOR SEnTIMEnT REPORT | 1

We believe that the hedge fund industry is entering the

third phase of a three-phase cycle, one that will be

characterized by moderate but sustainable growth, an

increased concentration of assets to established managers

and a stronger control environment.The rst phase began

with the sharp retrenchment o 2008 and continued through

the redemption-plagued months o early 2009. The second

was a period o extensive reallocation that we saw over the

course o late 2009 and 2010. The third phase will, in our

view, see signicant capital inows to the largest unds,

with a greater willingness on the part o investors to place

capital with established managers in emerging investment

vehicles. We also expect to see established managers grow

by acquisition as they seek smaller, standalone managers who

have been successul but have not been able to grow enough

to move to the next level.

For institutions, the hedge fund investment thesis still

holds. Institutional investors have indicated that they are

seeking superior risk-adjusted returns and diversication

rom their hedge und investments [ J.P. Morgan Asset

Management Alternative Assets Survey, 2010]. For the most

part, they are happy with the results they are getting.

Institutions now allocate more assets than ever beore to the

hedge und segment; they are more comortable with hedge

und strategies and better able to shape the terms o their

relationships with managers. Institutional investors appear to be investing with more

conviction. The great reallocation o 2010 has begun to wind

down. In 2008, 90% o our respondents had some portion

o their capital locked up or gated. By the end o 2010,

that gure had allen to 66%. Investors now appear to be

deploying new capital to the hedge und segment. Overall,

95% o respondents indicated that they would be increasing

their allocations to hedge unds in 2011, and many are now

willing to place capital with smaller unds. Strong asset ows

in the rst quarter o 2011 appear to be bearing this.

But they also remain cautious. In an eort to make more

inormed investment decisions, institutional investors

demanded improved transparency, liquidity and control in

2009. Overall, institutional investors perormed more due

diligence, required more thorough risk transparency and

requested shorter lock-ups and more requent redemption

periods. However, the required level o liquidity appears

to depend on investor type and geographical location. For

example, only 11% o North American respondents required

monthly redemption withdrawal periods, versus 38% in Asia

and 39% in Europe. Risk transparency seems to be critical

to almost all institutional investors as 94% o respondents

require at least summary inormation rom hedge und

managers on a regular basis.

The implications for hedge fund managers have not

changed. When looking to select a hedge und manager,

our respondents ranked Experience/Pedigree o Manager,

Investment Strategy, Perormance/Track Record and Risk

Management as the most important criteria or allocation.

We think that these results reafrm investors singular

ocus on perormance. Assets owed to the largest, most

proessionally managed unds. As established managers

who had opened up to new investor capital in 2009 have

begun turning away investors, our respondents indicated

that they had a growing interest in smaller and newer unds,

particularly by amily ofces, und o unds, consultants and

wealth management companies.

Several important areas of tension between institutional

investors and hedge fund managers persist. Over the

past several years, we have seen the power relationship

between investors and hedge unds evolve. Large investors

pensions, endowments and oundations, in particularhave

demonstrated the ability to drive change with the largest

impact on smaller hedge unds. Our analysis o hedge und

managers conrms that the majority o unds responding to

these demands were primarily smaller or newer managers.

However, through ollow-up conversations, we ound that

larger unds did succumb to investor demands when largeallocations were on oer. As investors reallocated into larger,

better perorming unds in 2010, they also strengthened the

position o what were already the most powerul managers.

Our studies show that these managers, many o whom

have actually turned away investors, are much less likely

to give investors the kind o transparency and liquidity

that they seek. Moreover, top perormers report that their

management and perormance ees remain where they were

beore the crisis.

The roles of consultants and funds of funds are evolving.

Since the rst quarter o 2010, we have witnessed hedge

und net asset ows grow by over $55 billion. Over the sameperiod, und o unds net asset ows ell by nearly $11 billion.

We believe that this signals a shit away rom investors use

o und o unds vehicles as they begin placing capital

directly into unds as opposed to placing money with und o

unds. The J.P. Morgan Capital Introduction Group: Institutional

Investor Survey, 2011 (known rom here on orward as CIG:

Institutional Survey 2011) revealed that investors expect to

hire consultants or investment expertise, while 9% o und

o unds expect to start providing advisory/consulting

services in 2011.

Executive Summary


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Introduction Letter

In the rst quarter o 2011, J.P. Morgans Prime Services Capital Introduction Group completed its survey o more than 300 o

the worlds leading institutional investors. Participant responses were thought-provoking and suggested that their behavior in2011 will dier rom 2010 in important ways. In order to urther test our central hypotheses, we also incorporated ndings rom

original studies perormed by the Prime Services and Asset Management divisions o J.P. Morgan, as well as those published by

selected third parties. This report describes our analysis and ndings.

Last year, we argued that changes in investor sentiment were driving a major shit in the allocation o institutional assets among

hedge unds that would redene the competitive landscape. We think the results o this years survey conrm that the great

reallocation that we posited in the 2010 report happened and has largely run its course. Institutional investors appear to be

cautiously optimistic. Hedge und managers have responded to investor demands in some constructive ways. In our view, the

hedge und industry is now entering the third phase o a three-phase cycle, one that will be characterized by moderate but

sustainable growth, an increased concentration o assets to established managers and a stronger control environment.

We hope that hedge und managers, investors and other market participants nd this report useul. We welcome any comments

that you may have regarding our views.

Best regards,

Louis Lebedi

Adrea Ageloe


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4 | Prime Brokerage

In last years report, we described a hedge und industry that,

on the surace, appeared to have rapidly rebounded rom the

nancial crisis and was positioned or a period o sustained

growth. The major hedge und indexes showed better risk-

adjusted return characteristics than most asset classes, and by

the beginning o 2010, net ows had begun to turn modestly

positive. Our survey conrmed that institutional investors

would continue to take a leading role in the hedge und

industrys repair, with 91% reporting they intended to increase

their allocations to the segment over the course o 2010.

Within the hedge und asset base, however, we believed that

a massive reallocation o capital was underwayone that we

elt would have important implications or the types o hedge

unds that would be successul in the uture.

By our estimates, more than a third o the hedge und asset

base was in motion by mid-2010. What was driving this

tectonic shit in the structure o the industry? In our view:

dierentiated perormance. A relatively small number o the

most proessionally managed unds outperormed hedge

und indices while maintaining liquidity or investors, while

during the same period, large numbers o smaller, less adeptly

managed hedge unds underperormed or ailed entirely.

Over 600 unds liquidated in 2010, more than double the

10-year average leading up to the nancial crisis. This shows that

there is still a very high level o attrition among unds [HFR Year

End 2010 Industry Report]. We ound that institutional investorshad begun to manage their positions ar more aggressively.

In all, 89% o the respondents to our institutional investor

survey last year said that they had redeemed some portion o

their hedge und investments, while many more indicated that

they would have redeemed but were still locked up in poorly

perorming vehicles as o the date o our survey. We ound

that as these investors reed up captive capital, they quickly

reallocated it to the managers that had proven their ability

to perorm through the cycle.

We believe that industry asset ows bear this thesis out.

From late 2009 through 2010, net inows to the hedge

und segment were positive but well below the average

inows o the 10 years leading up to the crisis. However,

the concentration o assets with the largest hedge unds

increased signicantly during this period. In 2004, hedge

unds managing more than $1 billion in assets accounted

or 65% o the industrys global asset base. By the ourth

quarter o 2010, that gure had surged to 84% [Hedge

Fund Intelligence, Global hedge fund assets up 11% in 2010and back above $2 trillion]. Our survey responses

or 2010 also bear this thesis out: 75% o respondents cited

redemptions as a source capital or their new hedge und

investments, and most o their investments were directed

toward the largest managers.

In last years report, we maintained that the implications

o our ndings or hedge und managers were clear. Risk-

adjusted perormance mattered above all else; it was the

#1 selection criteria or investors. We also ound that top

perorming managers oten had investors competing or a

limited number o allocations, enabling those managers to

have greater leverage in negotiating terms around liquidity

and transparency. Size also mattered. The largest unds

generally proved to be more scalable, more controlled and

more attractive to investors rom a perormance perspective.

Running multiple strategies within a und amily, but not within

a specic und, also helped to improve perormance and

attract capital rom investors seeking diversication. Finally,

proessionally operated unds that employed institutional

caliber controls and were capable o managing multiple prime

brokers were most likely to attract investors.

This years report is based on the J.P. Morgan Prime

Services Capital Introduction Groups survey o 363 o the

worlds leading institutional investors. The primary research

was conducted over the course o the ourth quarter o 2010

and rst quarter o 2011. In order to test additional hypotheses

and better explain certain trends, we also incorporated

data rom J.P. Morgans hedge und benchmarking survey

[J.P. Morgan Consulting Group Client Benchmarking Survey] and

analysis rom J.P. Morgans Asset Management division, as

well as select third party studies.

Sources o Capital or new Allocatios to Alteratives (2010)

% responses of total respondents

Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figure 1

49%

Reallocated Capital from

Other Asset Classes

77%

Redeployed Capital from

Returned Redemptions,

Lifted Gates, etc.

72%

New Capital

Overview: From Retrenchment to Sustainable Growth


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We believe that the hedge und industry is entering the

third phase o a three-phase cycle, one that will be

characterized by moderate but sustainable growth, an

increased concentration o assets to established managers

and a stronger control environment. The rst phase beganwith the sharp retrenchment o 2008 and continued through

the redemption-plagued months o early 2009. The second

was a period o extensive reallocation that we saw over the

course o late 2009 and 2010. The third phase will, in our

view, see signicant capital inows to the largest unds,

with a greater willingness on the part o investors to place

capital with established managers in emerging investment

vehicles. We also expect to see established managers grow

by acquisition as they seek smaller, standalone managers who

have been successul but have not been able to grow enough

to move to the next level. Other key ndings include:

For institutions, the hedge fund investment thesis still

holds. Institutional investors have indicated that they are

seeking superior risk-adjusted returns and diversication

rom their hedge und investments [ J.P. Morgan Asset

Management Alternative Assets Survey, 2010]. For the most

part, they are happy with the results they are getting.

Institutions now allocate more assets than ever beore to the

hedge und segment; they are more comortable with hedge

und strategies and better able to shape the terms o their

relationships with managers.

Institutional investors appear to be investing with more

conviction. The great reallocation o 2010 has begun to winddown. In 2008, 90% o our respondents had some portion

o their capital locked up or gated. By the end o 2010,

that gure had allen to 66%. Investors now appear to be

deploying new capital to the hedge und segment. Overall,

95% o respondents indicated that they would be increasing

their allocations to hedge unds in 2011, and many are now

willing to place capital with smaller unds. Strong asset ows

in the rst quarter o 2011 appear to be bearing this.

But they also remain cautious. In an eort to make more

inormed investment decisions, institutional investors

demanded improved transparency, liquidity and control in

2009. Overall, institutional investors perormed more due

diligence, required more thorough risk transparency and

requested shorter lock-ups and more requent redemption

periods. However, the required level o liquidity appears

to depend on investor type and geographical location. For

example, only 11% o North American respondents required

monthly redemption withdrawal periods, versus 38% in Asia

and 39% in Europe. Risk transparency seems to be critical

to almost all institutional investors as 94% o respondents

require at least summary inormation rom hedge und

managers on a regular basis.

The implications for hedge fund managers have not

changed. When looking to select a hedge und manager,

our respondents ranked Experience/Pedigree o Manager,

Investment Strategy, Perormance/Track Record and Risk

Management as the most important criteria or allocation.

We think that these results reafrm investors singular

ocus on perormance. Assets owed to the largest, most

proessionally managed unds. As established managers

who had opened up to new investor capital in 2009 have

begun turning away investors, our respondents indicated

that they had a growing interest in smaller and newer unds,

particularly by amily ofces, und o unds, consultants and

wealth management companies.

Several important areas of tension between institutionalinvestors and hedge fund managers persist. Over the

past several years, we have seen the power relationship

between investors and hedge unds evolve. Large investors

pensions, endowments and oundations, in particularhave

demonstrated the ability to drive change with the largest

impact on smaller hedge unds. Our analysis o hedge und

managers conrms that the majority o unds responding to

these demands were primarily smaller or newer managers.

However, through ollow-up conversations, we ound that

larger unds did succumb to investor demands when large

allocations were on oer. As investors reallocated into larger,

better perorming unds in 2010, they also strengthened the

position o what were already the most powerul managers.

Our studies show that these managers, many o whom

have actually turned away investors, are much less likely

to give investors the kind o transparency and liquidity

that they seek. Moreover, top perormers report that their

management and perormance ees remain where they were

beore the crisis.

The roles of consultants and funds of funds are evolving.

Since the rst quarter o 2010, we have witnessed hedge

und net asset ows grow by over $55 billion. Over the same

period, und o unds net asset ows ell by nearly $11 billion.

We believe that this signals a shit away rom investors useo und o unds vehicles as they begin placing capital

directly into unds as opposed to placing money with und o

unds. The J.P. Morgan Capital Introduction Group: Institutional

Investor Survey, 2011 (known rom here on orward as CIG:

Institutional Survey 2011) revealed that investors expect to

hire consultants or investment expertise, while 9% o und

o unds expect to start providing advisory/consulting

services in 2011.


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6 | Prime Brokerage

Institutional investors have been steadily increasing their

overall level o investment in hedge unds segment or years.

In 1999, 46% o hedge und capital ows were sourced

through institutions. By 2009, institutions accounted or the

majority o the assets in the space [IFSL, Hennessee Group LLC].

A study by the research rm Preqin in the rst quarter o 2011

highlighted the pivotal role that institutional investors now

play in the industry. Nearly hal o the hedge und managers

they surveyed reported sourcing more than 60% o their

capital rom institutions; 28% reported sourcing more than

80% o their capital rom institutions [Preqin Hedge Fund

Manager Study, Feb. 2011]. In Q1 2011 alone, pension unds

allocated $18 billion to hedge unds; Pensions & Investments

magazine reports that the combined total o net inows and

pending searches is the highest in our years with institutional

investments back to pre-2008 levels.

Institutional capital has become increasingly critical to hedge

und managers as they become larger. Hedge unds managing

$10 billion or more in assets reported that, on average, 67%

o their capital originated rom institutional sources. The

importance o institutional investors is likely to increase in

2011. Analysis by J.P. Morgans Prime Brokerage business

concluded that nearly hal o the hedge unds managing more

than $1 billion in assets, the segment most likely to source an

overwhelming majority o capital rom institutions, plan to add

unds in 2011, and Preqin ound that 84% o its respondents

expect to increase the proportion o their capital base sourced

rom institutional investors.

Global Compositio o Hedge Fud Capital Flows

Source: IFSL, Hennessee Group LLC Figure 2

0%

20%

40%

60%

80%

100%

IndividualsInstitutional Investors

46%

54%

1999

74%

26%

2009

44%

56%

2005

Average % o Hedge Fud Capital rom Istitutioal Ivestors by

Maager AUM (2011)

Source: Preqin Hedge Fund Manager Study, February 2011 Figure 3

>$10 BN$19.9 BN$500999 MM$250499 MM$5 BN

44.7

$15 BN

5.6

(2.8)

$500 MM1 BN

$250500 MM

2.4

$100250 MM

2.2


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Are institutional investors getting the results theyre looking

or rom their hedge und investments? Ater all, investors

could simply be chasing returns by rotating capital into hedge

unds because they perormed better than other asset classes.

Hedge unds are an expensive way to generate returns, and theinvestor/manager relationship can be complex. I institutional

investors nd themselves dissatised with the results o their

orays into the space, there could be another major wave o

redemptions. Through primary research, we have ound that

institutional investors mainly seek two things rom their hedge

und investments: superior returns per unit o portolio volatility

and diversication into less correlated asset classes. Through

ollow-up conversations, some managers have increasingly

mentioned capital preservation as a high priority. This

eedback is consistent with the larger stress on diversication

and reduction o volatility [ J.P. Morgan Asset Management,

Alternative Assets Survey, 2010]. It appears that hedge unds

have delivered, though some strategies and managers have

perormed better than others. Looking at returns o pension

und portolios or the one-, three- and ve-year time horizons

dating rom June 2010, Preqin ound that hedge unds

generally outperormed their expectations on a total returnbasis. More importantly, returns or the 12 months ending

June 2010 exceeded the expectation by an average o 365 basis

points. Because these returns were measured in the midst

o a major reallocation o assets, they include trailing data

rom underperorming unds that were later redeemed and,

thereore, probably dampen overall returns. A comparison o

the cumulative returns o major hedge und indexes to those

o major stock and bond indexes conrms the point. A look

at returns rom the 12 months ending December 2010 shows

that 19 out o 25 hedge und strategies outperormed the

major stock and bond indexes on a risk-adjusted basis.

Istitutioal Ivestors Greatest Advatages o Ivestig

i Hedge Fuds (% o respodets)

Source: J.P. Morgan Asset Management, Alternative Assets Figure 6

Diversification

73%

Returns

63%

Volitility of Returns

51%

Media Returs o Public Pesio Plas by Asset Class

as o Jue 30, 2010


Hedge Funds Listed Equity Private Equity

Real Esta te Tota l Investment Portfol io

Fixed Income

1 Year 5 Years3 Years-15%

-10%

-5%

0%

5%

10%

15%

20%

Cumulative Returs, 20072010

Source: Indices Figure 8

Eureka Hedge Euro Hedge HFRI DJ/CS

HF Index

MSCI World Barc lays Govt/

Credit Index Bond

S&P 500

Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10

40

50

60

70

80

90

100

110

120

130


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8 | Prime Brokerage

For institutional investors capable o securing stakes in top

perorming hedge unds, a number o compelling investment

opportunities exist. For hedge und managers, the institutional

investor base represents an increasingly crucial source o

capital. The opportunity or high quality managers could

be enormous. A Pensions & Investments/Towers Watson

survey in the ourth quarter o 2010 shows the total assets

o the worlds 500 largest institutional investors at nearly

$62 trillion [Pensions & Investments /Towers Watson World

500: The Worlds Largest Money Managers, 10/18/2010].

But allocations to hedge unds remain relatively small.

The percentage o public pension und investments in hedge

unds, or example, has nearly doubled since 2007, but it still

remains at only 6.6% o their total portolios. Hedge und

managers ace a number o signicant challenges when dealing

with institutional investors. Overall, however, we believe that

institutional investors are helping to make the hedge und

segment more transparent, eectively controlled and likely to

deliver superior risk-adjusted returns (more on these points

to ollow). In our view, the case or hedge unds remains a

strong one rom the perspective o most institutional investors.

The case or institutional capital rom the perspective o hedge

und managers has become convincing as well.

HFRI Idex Risk Retur Compariso, 2010

Source: HFR Year End 2010 Industry Report Figure 9

Asset-Backed

EqMktBNtrlMerg Arb

RV: Multi

RV

EM: LatAm

Short Bias

EAFE

MSCI World

Energy

EM: Russia

Emerging Markets

Macro

EM: Global

Yield Alts

S&P 500

0 5 10 15 20 25

(25)

(20)

(15)

(10)

(5)

0

5

10

15

20

FI Corp

Barclays Govt/Credit

EHConv Arb E-D

FWC

Reg D

Distressed DJ/CS HF

FOF

Quant/DrectnlMacro: Sys Div

EM: Asia ex-JapanTech/HC

Standard Deviation (%)

Return(%)

Public Pesio Fud Allocatios to Hedge Fuds, 2007Preset


2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Q1 2011

6.6%6.5%

Q4 2010Q4 2009

6.0%

Q4 2008

5.7%

Q4 2007

3.6%


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We believe that the hedge und industry is entering the third

phase o a three-phase cycle, one that will be characterized by

sustainable growth, increased concentration o assets and a

stronger control environment. The current cycle began in 2008,

with the retrenchment in global markets. Hedge unds assets

declined by 31% between the second quarter o 2008 and the

rst quarter o 2009. In the aggregate, they outperormed

most asset classes. Overall, hedge unds provided better

total returns than equities and better risk-adjusted returns

than bonds throughout the crisis. Still, rom the third quarter

o 2008 to the ourth quarter o 2009, investors withdrew

over $329 billion [HFR Third Quarter 2009 Industry Report]. In

previous studies, we ound that much o the capital outow was

driven by high net worth investors that required liquidity or a

variety o reasons, not all o them related to the perormance

o their hedge unds positions. By the second hal o 2009, the

hedge und asset base was sourced primarily rom institutional

investors and high net worth individuals that took a long-

term view. The act that many institutional investors saw

hedge unds as an attractive investment class does not mean

that they were particularly satised with the hedge und

position that they actually held. This brought about the

second phase o the current cycle: reallocation. Over the

course o late 2009 and early 2010, we believe that more

than a third o all hedge und assets were in motion

[Tectonics: Shifting Investor Sentiment and the Implicationsfor Hedge Fund Managers, J.P. Morgan Prime Brokerage,

September 2010]. Most o the capital in ight during this

period did not appear to be new money coming into the

hedge und space but rather, existing capital being shited

rom managers that underperormed during the crisis to

those that outperormed. From the rst quarter o 2009

through the ourth quarter o 2010, hedge und assets

increased by $586 billion, a growth o 44% [HFR Year End

2010 Industry Report]. However, all o that growth came

rom manager perormance; investors pulled out a net o

$76 billion during this period [HFR Year End 2010 Industry

Report]. Capital ows turned positive in the second hal o2009, but since then, quarterly new investment has been

modest, averaging 3.5% o global AUM versus the 20002008

average o 10.4% [HFR Year End 2010 Industry Report].

Entering 2011, we believe that institutional investors are

cautiously optimistic about, and increasingly demanding o, the

hedge und segment. This year, 95% o CIG: Institutional Survey

2011respondents said that they intend to make new allocations

to hedge unds in the coming 12 months. This gure increased

rom 88% in 2009 and 91% in 2010. The average size o hedge

und allocations has already begun to increase; the percentage

o CIG: Institutional Survey 2011 respondents making average

allocations o at least $25 million improved rom 18% in

2008 to 32% in 2010. Pension, endowment and oundation

managers, as well as large insurers, were the investors

most likely to make these large placements. The majority

o CIG: Institutional Survey 2011 respondents indicated that

they plan to increase the number o hedge unds they invest

in over the next 12 months as well. Interest was particularly

strong among pension, oundation and endowment managers,

71% o whom indicated that they will increase the number

o hedge unds into which they have made placements.

Additionally, we ound that many o the largest pensions,

particularly in North America, remained signicantly

underunded and see hedge unds as a way to build back

Three-Phased Cycle: The Hedge Fud Eviromet, 20082011P


Q12011

Q22011

0.00.20.40.60.81.01.21.41.61.82.02.2

Q12008

1.88

Q22008

1.93

Q32008

1.72

Q42008

1.41

Q12009

1.33

Q22009

1.43

Q32009

1.54

Q42009

1.60

Q12010

1.67

Q22010

1.65

Q32010

1.77

Q42010

1.922.01

Retrenchment Reallocation Regeneration

$

Billions

Global Asset Ifows/Outfows, 20002010


Average inflowsof total assets

3.5%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

(200)

(150)

(100)

(50)

50

100

150

200

250 Average inflows

of total assets

10.4%

$

Billions

II. Regeneration


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10| Prime Brokerage

their asset base. More than two-thirds o consultants,

an increasingly important market participant, indicated thatthey would also be increasing the number o unds that they

placed with.

Investors are positioned to act. Fewer now nd themselves

invested in hedge unds that have redemptions suspended

or gated. In the CIG: Institutional Survey 2011, 66% o

respondents reported that some percentage o their portolio

was subjected to these provisions, but nearly 90% had less

than 10% o their capital held up. More than 80% o CIG:

Institutional Survey 2011 respondents reported that they have

less than 10% o their portolios in cash, whereas in 2008,53% had more than 10%, indicating that they have begun to

put capital to work. In 2009, 18% o CIG: Institutional Survey

2011 respondents reported that 75% o their hedge unds

had returned to their high water marks. This year, hal o the

CIG: Institutional Survey 2011 respondents said that at least

75% o the managers that they invested in had reached their

high water marks.

Percetage o Respodets Itedig to Allocate to Hedge Fuds

(20092011E)


2009

88%

31%

2010

91%

45%

2011 Expected

95%

53%

Increasing # of HF InvestmentsIncreasing Total Allocation

Ivestors Makig Average Allocatios to Hedge Fuds Greater Tha $25MM


2009

22%

18%

32%

20102008

Wealth Manager Insurance Company Fund of Funds Famil y Oce Endowments, Foundations and PensionsOther BankConsultant

Percet o Hedge Fuds Subject to Gatig or Lock-Up Provisios

(20082010)


2010

66%

2009

84%

2008

90%


15/32


How are investors acting on their sentiments? We ound that

the majority o them are taking a long view. Overall, 90% oCIG: Institutional Survey 2011 respondents reported that

the duration o their typical hedge und investment is longer

than two years. Most reported that the typical duration is two

to ve years. However, 25% stated that their typical investment

in hedge unds is held or more than ve years. This shows a

marked increase rom the 16% that gave the same response

in 2008, when redemptions were quite common. We also

ound that investors with more experience investing in hedge

unds tend to make larger placements. In the CIG: Institutional

Survey 2011, investors with more than 10 years o experience

managing hedge und positions accounted or only hal o

our respondents, but 70% o the assets placed. Conversely,

those with ewer than three years o experience placed only

2% o the capital. In all, 48% o CIG: Institutional Survey 2011

respondents with more than 10 years o experience reported

that the size o their average hedge und investment was

larger than $25 million. For those with one to three years o

experience investing in hedge unds, only 6% reported an

average allocation o more than $25 million. No respondents

with less than a year o hedge und investing experience made

placements larger than $25 million.

As we have ound in previous research, investors responding

to the CIG: Institutional Survey 2011 had disparate views onwhich strategies they will be allocating toward in the coming

months. There were, however, our overarching themes. First,

respondents clearly identied several strategies o interest;

between 20% and 25% indicated that they will increase their

allocations to macro, event driven, emerging markets and

undamental long/short managers, and 17% slated managed

utures or increases. These gures are roughly similar to

what respondents said last year, though the number saying

they would allocate more to managed utures strategies

decreased by a meaningul amount year over year. Second,

respondents generally agreed that they will reduce their

allocations to two types o strategies in particular. Managers

running multiple strategies within a single und will likely

receive substantially less capital this year, as nearly a quarter

o CIG: Institutional Survey 2011 respondents indicated that

Respodets Hedge Fud Holdigs Gated

or Uder Redemptio Suspesio i 2010

Source: J.P. Morgan Capital Introduct ion Group: Institut ional Investor Survey, 2011 Figures 16 and 17

Cash Positios as a Percet o Total Portolio (2010)

Greater than 25% Gatedor Suspended 2%

1025% Gated

or Suspended 10%

110% Gated

or Suspended 54%

0% Gated

or Suspended 34%

Greater than 50% Cash 1%

2550% Cash 3%

10-25% Cash 14%

5-10% Cash 29%

Less than 5% Cash 52%

Typical Duratio o Ivestmet (20082010)


0%

20%

40%

60%

80%

100%

25 years 12 yearsGreater than 5 years

2008 20102009

74%

10%

65%

10%12%

69%

16% +3% +6% 25%19%

Hedge Fud Ivestig Experiece by number o Respodets

ad AUM Ivested


51%

22%

17%9% 1%

70%

18%

100% 100%

10% 2%

HF Investing Experience

by AUM in HFs

HF Investing Experience

by # of Respondents

710 years 46 years

13 years Less than 1 year

Greater than 10 years


16/32

12 | Prime Brokerage

they would be reducing their allocations to these types o

unds, while only 9% said that they would increase. We mayvery well see these multi-strategy unds lower their

perormance or management ees in order to prevent these

capital outows. Respondents also generally agreed that

they would be reducing their allocations to und o unds,

something that we think will have important implications or

consultants. The third theme derived is that investors are

likely to maintain their current geographic allocations,

which have remained airly constant over the course

o the past three years. The nal theme is dissonance.A quarter o respondents stated that they plan to

increase their allocation to macro strategies, but 19%

said that they plan to decrease. Fundamental long short,

one o the our most popular strategies or new allocations

among respondents, is likely to have an equal number o

investors redeeming. In act, every strategy can expect to

see capital outows to some degree.

Respodets Icreasig/Decreasig Exposure by Strategy (2011)


1%

2%

2%

4%

6%

6%

7%

8%

8%

-10%

-4%

-2%

-5%

-10%

-6%

-4%

-11%

-12%

9%-24%

9%-8%

10%

10%

-9%

-5%

11%-22%

17%-6%

20%-19%

22%

24%

-8%

-10%25%-19%

-25% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% Net % Change

MacroEvent Driven

Emerging Markets

Long Short Equity: Fundamental

CTAs/Managed Futures

Credit Strategies: Corporate Credit

Commodities

Credit Strategies: Structured Credit

Long Short Equity: Sector

Multi-Strategy

Fixed Income Arbitrage

Long Short Equity: Market Neutral

Long Short Equity: Quantitative

Long Short Equity: Long Biased

Convertible Arbitrage

Options Arbitrage

Long Short Equity: Short Biased

Unhedged Equity: Long Only

Fund of Funds

+6%+14%

+14%

+1%

+11%

-11%

+5%

+1%

+1%

-15%

-4%

-3%

+3%

0%

-4%

-1%

0%

-2%

-9%


17/32


Investors expect the roles o consultants and und o unds to

continue evolving. We ound that large investors have begun

to increasingly use consultants to help them invest directly

into hedge unds. In 2010, new capital invested directly into

hedge unds totaled $55 billion. Fund o unds investors saw

capital outows o $11 billion during the same period. Despite

the und o unds outows, we believe that the sector will

continue to play an important role in the industry, but in order

to regain its dominance, it will need to deliver services and

perormance that rationalizes the extra layer o ees. We have

already seen a trend as und o unds begin to blur the lines

with consulting rms and oer additional services. Nearly hal

o the und o unds managers we surveyed launched advisory

services by late 2010, and 83% o them charged a separate ee

or consulting services. In some cases, we have seen und o

unds managers oer the advisory services or ree. However,

we also ound that less than 10% o investors used und o

unds or advisory services.

In our view, hedge unds are well positioned to increase their

share o global investment capital. However, the institutional

investors that we think will be allocating the vast majority

o the new capital are making signicant demands on hedge

und managers. Selection criteria is exacting. Due diligence

is intense. Investor demands or transparency, liquidity and

controls are acute. We believe that these trends are secular,

not simply a hangover rom the crisis period. Overall, we think

that institutional investors will drive improvements through

the upper tiers o the hedge und industry. We also think that

these trends will drive additional costs and behavior changes

into the space.

Fud o Fud vs. Hedge Fud Idustry net Asset Flows

(Q2 2009Q4 2010)


Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10

(32.2)

(42.8)

Industry FlowFoF Flow

(3.3)

(11.9)

(2.0)

1.1 2.5

13.8 13.89.5

19.0

0.3 1.8

13.2

III. Proceeding with Caution

Fud o Fud Respodets that

Act as a Advisor/Cosultat (2010)


Respodets Who Use a Cosultat (2010)

Expect to Start Providing

Advisory/Consulting

Services in 2011 9%

No 43%

Yes 47%

Expect to Start Using One 1%

Yes 17%

No 82%


18/32


We have ound that over the past three years, institutional

investors consistently stress the same criteria when selecting

hedge unds in which to allocate: the managers experience,

pedigree and perormance history, in addition to the specic

strategy employed. Investors cite a number o other issues asbeing highly important to them, such as risk management,

transparency, lock-ups and ees. However, the decision to

allocate does appear to come down to whether the manager

has demonstrated the ability to deliver high quality returns

and whether the strategy employed ts the investors overall

portolio. We ound that or institutional investors, a hedge

unds prime broker is not a top priority in manager selection.

However, it can be a reason not to allocate. Nearly hal o

CIG: Institutional Survey 2011 respondents indicated that

they would decline investing in a hedge und because o the

managers choice o prime brokers. Two-thirds responded that

they would decline investing because o a managers choice

o administrator.

Increasing numbers o CIG: Institutional Survey 2011

respondents have stated their willingness to invest in smaller

unds. In 2010, und o unds, amily ofces and wealth

management companies were the segments most likely

to invest in managers with less than $100 million in assets.

Overall, 69% o CIG: Institutional Survey 2011 respondents

indicated that they would be willing to invest in start-

up hedge unds, though most said that they would do so

selectively. In ollow-up conversations with investors, we

ound that many were interested in smaller unds primarilybecause the largest managers were beginning to close.

Some investors elt that they were being crowded out

o certain hedge und investment opportunities by large

institutions, particularly pensions, endowments, oundations

and insurance companies that were willing to make substantial

placements. Many investors have concentration limits,

and these large institutions are oten orced to ocus their

eorts on the largest managers. Not surprisingly, 43% o

respondents to the CIG: Institutional Survey 2011 who made

average investments o more than $250 million stated that

they required a hedge und to manage assets o more than

$1 billion beore they would consider making an allocation.

A secondary but important motivation or many investors

was the opportunity to take a large stake in a newer vehicle

in its early years, when investing experience suggests

it should have its strongest returns [The Performance

of Emerging Hedge Fund Managers, Rajesh K. Aggarwal

(University of Minnesota) and Philippe Jorion (University

of California/Davis) working paper, January 2008].

Top Priority Whe Selectig a Hedge Fud Maager, 2010


+3%

+1%+2%

+1%

+4%

-2%-1%

-3%

-1%

-2%

Experience/Pedigree of Manager

Investment StrategyPerformance/Track Record

Risk Management

Drawdown Statistics

Transparency

Lock-up Provisions

% of Liquid Net Worth ofManager Invested in the Fund

Leverage

Other

0%YoY % Change 10% 20% 30% 40%

Ivestors Willig to Ivest i a Start-Up Maager (2010)


Yes 10%

No 31%

Selectively 59%

Miimum AUM Required to Ivest i Fud (20092010)


$0 MM $50 MM $100 MM $250 MM $500 MM $1,000 MM

20102009

25%

37%

27%

15%

27%

13%

24%

14%

4%8%

0%

10%

20%

30%

40%

4%2%

Hedge Fud Perormace by Age o Fud

Source: The Perormance o Emerging Hedge Fund Managers, 2008 Figure 27

0.38%

3-9 years

9.15%

2.71%

02 years

10.08%

Average AlphaAverage Return

0%

6%

4%

2%

8%

10%

12%


19/32


Interest in investing in smaller unds, however, does not

appear to have translated into interest in developing untested

managers. Perormance and pedigree still matter. So does the

maturity o the und. Only 40% o CIG: Institutional Survey

2011 respondents indicated that they would be willing to

invest at inception, and just under hal require a minimum o

one years track record to even consider investing. When the

responses are considered in the context o asset weighting,

the environment or less tested vehicles becomes more

challenging. The majority o pensions, oundations and

endowmentswho control the lions share o the assets and

make the largest placementsrequire that the managers they

allocate to have at least two years o perormance history.

Additionally, we have ound that while many investors are

willing to make placements in small or start-up unds, those

unds are likely to be managed by experienced managers and

not new entrants.

On average, most respondents said that they spent three to

six months on due diligence; nearly 20% said that they spent

6 to 12 months. The majority o respondents reported that

they increased the depth and breadth o their due diligence

rather than the requency. A clear majority increased due

diligence out o concern over operational issues. The average

number o due diligence questionnaires elded per month

by J.P. Morgans Prime Brokerage Group increased by 250%

between 2008 and 2010. Responding pensions, endowments,

oundations and wealth management companies were

signicantly more likely to spend over six months on due

diligence than other investors.

Greater tha Six Moths to Complete Due Diligece

by Ivestor Type (2010)


Wealth

Management

Company

30%

Family Oce

23%

Insurance

Company

20%

Consultant

18%

Fund of Funds

17%

Bank

12%

Endowment,

Foundation

and Pension

31%

Average Time to Complete Due Diligece (20072010)

Source: J.P. Morgan Capital Introduct ion Group: Institut ional Investor Survey, 2011 Figure 31

14%

22%

20102007

612 monthsGreater than 1 year

Ivestors Willig to Lock-Up or More tha Two Years

(20082010)


2008 2009 2010

49%46% 45%


Miimum Track Record Required

to Make Ivestmets (2010)

Miimum Track Record Required to Make Ivestmet

by Edowmets, Foudatios ad Pesios (2010)

3 years or more 17%

2 years 19%

1 year 13%

6 months 11%

Fund Inception 40%

Greater than 2 years 63%

1 year 3%

6 months 3%

Fund Inception 31%


20/32


Investors continue to stress the importance o liquidity.

More than hal o our respondents would not commit to a

lock-up period o over one year. Sentiment varied greatly by

segment, however. Nearly 75% o endowments, pensions and

oundations respondents indicated they would accept lock-upso over two years, while other segments were less willing to

make comparable commitments. Most responding investors

require liquidity quarterly, and only 22% require it more

requently. Liquidity requirements vary by region. Only 11% o

North American investors reported that they require monthly

liquidity, compared to 38% or Asian investors and 39% or

Europeans. More than 15% o North American investors

were willing to accept semi-annual or annual liquidity, and

20% said that they had no real preerence. In ollow-up

discussions with investors outside o North America, moreaccessed hedge unds through und o unds platorms and

had the need to manage heightened asset/liability mismatch

risk. Additionally, the allout rom the Mado scandal has

been particularly impactul on investor sentiment outside

the United States.

Required Liquidity (2010)


No Preference 15%

Monthly 22%

Quarterly 53%

Semi-annually 5%

Annually 5%

Logest Acceptable Lock-Up Period (2010)


None 6%

6 months 6%

1 year 43%

2 years 28%

3+ years 17%

Respodet Base (2010, based o umber o respodets)


Yes 29%

No 71%

Yes 27%

No 73%

Planning to Invest via Managed Accounts Planning to Invest via UCITS


21/32


Managed accounts and UCITS structures oer investors

platorms with the potential to satisy their requirements or

increased liquidity. Interest in both, however, has been limited.

In 2009, nearly 40% o our respondents indicated that they

planned to invest in managed accounts in the coming year.Less than 20% actually did. At the end o 2009, 34% o our

respondents said that they intended to invest in UCITS in the

coming year. Only 19% did. Many o the more experienced

investors polled said that while requent liquidity was attractive,

they were concerned that constant changes in the capital base

would negatively impact perormance. Additionally, responding

investors in all regions acknowledged that these more liquid

vehicles were only suitable or specic, airly straightorwardstrategies. Another signicant impediment appears to be

structural. In all, 25 to 30% o responding investors indicated

that they were interested in making placements in these more

liquid platorms in 2011. Less than 5% o hedge und managers

indicated that they planned to launch a UCITS strategy in

2011. For und managers, the operational complexity and

increased expenses associated with these strategies make

them attractive only when they garner very substantial

placements. Many managers that we spoke with indicated

that they would consider launching a UCITS or a managed

account oering only i they could place substantially more

than $100 million into it. With 83% o our responding investorsstating they intend to invest less than $25 million in separately

managed accounts, the mismatch becomes obvious. Assets in

both managed accounts and UCITS have increased in recent

quarters; UCITS experienced a substantial one-year growth in

2010 with total assets under management increasing 198%

to $90.5 billion [Absolute UCITS]. While this surge in AUM issignicant, the total asset base remains relatively small when

compared to a total hedge und asset base o $2 trillion. While

we believe that these assets will continue to grow, we also

believe that the total allocations to these improved liquidity

vehicles will likely remain modest in comparison to the hedge

und segment as a whole.

Transparency continued to be an area o intense ocus or

investors as we entered 2011, but the degree o transparency

required diered greatly depending on investor type. Overall,

we ound that a meaningul percentage o respondents

increased their transparency requirements rom moderateto high, meaning that they required position-level detail on a

recurring basis. Only 6% o respondents surveyed stated that

they required nothing more than quarterly or monthly letters.

Among these respondents, consultants and und o unds, not

surprisingly, were signicantly more likely to require high

levels o transparency. Both, or example, reported that they

required high levels o transparency at double the rates that

wealth management companies, insurers and amily ofces

did. The majority o those that were more likely to invest

directly, or via a und o unds or consultant, reported that

they required moderate levels o transparency.

Maagers Itedig to Lauch a UCITS Strategy i 2011

Source: J.P. Morgan Consulting Group Client Benchmarking Survey Figure 36

Possibly

14%

No

81%

Yes

4%

Currently Have One

1%

Risk Trasparecy Required by Respodets (2010)


Limited (monthly/quarterly

letters only) 6%

Moderate (summary information

on a regular basis) 61%

High (position level detail

on a regular basis) 33%


22/32


In conversations with investors, we consistently ound that they

viewed the lack o transparency to be a critical impedimentto growth in the hedge und segment. For many strategies

it makes sense to restrict liquidity; too much liquidity can

damage returns. But the continued lack o transparency, rom

the perspective o our investors, was something that they

ound to be less easy to accept; the technology is too widely

available. Additionally, a hedge und managers ability to deliver

a reasonable level o transparency is oten viewed by investors

as a general barometer or their overall control environment.

From discussions with individual investors, we ound that one

o the main reasons why investors are asking managers or

current and historical holdings is their concern over assets

that could be illiquid and problematic i another nancial crisiswere to occur. Overall, a third o our respondents reported that

they required high levels o transparency, but only 20% o

the managers we polled said that they provided it. We turned

to our hedge und managers to nd out more about the kinds

o transparency they were providing. The primary determinant

o high transparency appeared to be the perceived, or actual,need or the manager to provide it, in order to attract a critical

mass o institutional capital. Hal o the emerging managers

that we polled provided high levels o transparency. They

were the most willing to provide position-level data by a

substantial margin. They were also the managers with the

least assets and most were seeking to raise additional capital.

A third o mid-sized credit unds and a quarter o credit unds

managing $150 million to $500 million in assets reported

providing current holdings transparency to investors. Credit

unds can be particularly complex, and we were somewhat

surprised that so many managers provided high levels o

transparency. From discussions with managers, we knew thatmost o these unds were also seeking to raise capital as well.

Far ewer credit und managers in the Billion Dollar Club were

seeking new capital, and less than 13% o them reported that

they were providing high levels o transparency. Long/short

Risk Trasparecy Required by Ivestor Type (2010)


0%10%20%30%40%50%60%

70%80%90%

Moderate LimitedHigh

32%

11%

44%

58%

7%

41%

4% 7%

55%

20% 20%

73%80%

75%

44%

31%

11%18%

64%

Bank Consultant Family Oce Fundof Funds

InsuranceCompany

WealthManagement

Company

Endowment,Foundationand Pension

4%

Trasparecy Levels or Ivestor Reportig Across All Fuds

Source: J.P. Morgan Consulting Group Benchmarking Survey Figure 39

Portfolioand RiskAttributes

78%

35%

CurrentTop 10

Winners& Losers

HistoricalHoldings(1 month

prior)

22%

CurrentHoldings

19%

HistoricalHoldings

(3 monthsprior)

19%

PerformanceAttribution

73%

Most Transparent Least Transparent

Most Trasparet Reportig Optio by Fud Category: Curret Holdig Frequecy


50%

33%

25%

20%

13%

10%

7%

0%

29%

$0150 MM Emerging Managers

$500 MM$1 BN Credit

$5 BN+ Multi-Strategy

$150500 MM Credit

$110 BN Long/Short Equity

$1 BN+ Credit

$500 MM$1 BN Long/Short Equity

$15 BN Multi-Strategy

$150500 MM Long/Short Equity


23/32


equity managers are probably the ones whose strategies most

lend themselves to transparency, yet 80% o these managers

with between $1 billion to $10 billion in capital did not provide

investors inormation on current holdings.

When we looked at the type o inormation that managers

were providing, we ound that nearly two-thirds gave

investors perormance attribution reporting and nearly 80%

published portolio and risk analytics. These types o reports

are challenging to produce in a timely and accurate manner

when acing o against multiple prime brokers. We saw the

high incidence o report provision in these two areas as

consistent with a trend that we had identied in previous years,

namely that hedge und managers were increasingly investing

in middle ofce technology in order to complete the value

chain between their portolio managers and traders. Less than

a third o managers we surveyed were providing other typeso inormation, such as historical holdings or winning and

losing positions.

We ound one additional response to be particularly striking.

In 2010, 24% o CIG: Institutional Survey 2011 respondents

indicated that they purchased a tail risk product. This suggests

that nearly a quarter o institutional investors bought in to

an investment strategy that barely existed three years ago.

Moreover, 35% o our respondents indicated that they expect

to invest in a tail risk product in 2011. The hedge und segment

may be poised or a period o sustainable growth, but investors,it appears, will be looking over their shoulders or some time

to come.

Respodets Ivested i a Tail Risk Product (20102011P)


2011P2010

35%

24%


24/32

20| Prime Brokerage

Institutions have begun to change the nature o the larger

relationships that hedge und managers have with their

investors in important ways, reecting a shit in the relative

power held on either side o the capital equation, but one

that has been unevenly realized. Over the course o the

past two years, the majority o institutions have successully

renegotiated some portion o their agreements with at least

one o their hedge und managers. This has been particularly

true o investors that make large placements. However, as the

great reallocation played out over the course o 2010, capital

shited to the largest hedge und managers with the most

attractive perormance characteristics. These managers have

proven to be much less likely to make signicant changes in

order to accommodate investors. Our 2009 and 2010 studies

depict an industry in ux. We believe that increasing inuence

o the largest institutional investors will continue to drive

change through 2011, but they will come up against some

immovable objects in the orm o very large hedge unds that

have no shortage o investor interest.

In 2010, 37% o responding investors reported that they

renegotiated management ees and 25% said that they

renegotiated perormance ees. Overall, 87% indicated

that they redeemed rom a hedge und. We think that two

things stand out about these responses. First, nearly hal

o our responding investors making average placements

o between $25 million to $100 million were successulin renegotiating core terms with at least one o their

hedge und managers. Only 21% o responding investors

whose average placements were between $1 million to

$5 million were able to win similar concessions. In ollow-up

conversations with these investors, we ound that most used

a period o subpar, but not poor, relative perormance as an

opportunity to reprice the relationship. They extracted other

concessions as well, such as reduced lock-ups and improved

liquidity. Smaller investors were not nearly as successul in

convincing even underperorming managers to move in their

direction on terms. The second aspect o these responses that

we elt signicant was that the leading reasons or redemptions

were related to poor or erratic perormance. In 2010, as in 2009,

the overwhelming majority o respondents redeemed because

their hedge und investment underperormed. Another leading

reason was style drit, which was also perormance related.

Considerably urther down the list were liquidity-related

issues, but these only became material when the manager was

underperorming and the investor was trying to exit. Issues like

lack o transparency and inadequate communication were down

the list as well. Investors wanted liquidity, transparency and

controls. But they wanted perormance even more. We ound

that the largest investors have been successul in convincing

many hedge und managers to provide improvements in these

areas, but the change was concentrated amongst the ranks

o the smaller and/or underperorming managers.

Respodets Who Reegotiated the Maagemet Fee

with Hedge Fud Maagers (2010)

Source: J.P. Morgan Capital Introduction Group: Institutional Investor Survey, 2011 Figures 43 and 44

Respodets Who Reegotiated the Perormace Fee

with Hedge Fud Maagers (2010)

Yes 37%

No 63%

Yes 25%

No 75%

IV. Balance o Power

Respodets Who Redeemed rom a Hedge Fud (2010)

No 13%

Yes 87%



25/32


One o the signicant impacts o reallocation in 2010 is that

the relative strength o the largest hedge und managers

increased. Industry statistics showing increased concentration

are clear, and we ound similar results in our polling data. In

all, 48% o hedge unds managing over $1 billion in assetsthat we surveyed stated that they added unds in 2010; only

8% said that they subtracted unds. Many o these large

managers also opened existing vehicles to new investors.

More than 85% o these hedge und executives indicated that

their management ees were still above 1%; over hal charged

2% or more. Perormance ees remained in the 20% range

or roughly 85% o these same managers, and 7% charged

even more. As we discussed earlier, most o the largest hedge

unds have done little to increase transparency and liquidity.

It does appear, however, that they made signicant eorts to

improve controls. More than 80% o hedge unds managing

$1 billion or more in assets that we surveyed indicated that

they employ a chie compliance ofcer. More than 95% o

these managers said that they had either already registered

with the SEC or are planning to register. Most will argue that

there is room or improvement, but most also say that they

have seen real progress. Improving the control environment

requires real investment on the part o hedge und managers.

However, it also delivers real benets in a market where

managers oten run multiple strategies in multiple regions

and ace o against multiple prime brokers. Which brings

us back to the core issue: by rotating so much capital into

the largest hedge unds, investors have bought into hedge

unds with superb track records, but they have also shited

the balance o power in many core relationships over to

the manager.

Hedge Fuds Addig or Subtractig Fuds i 2010


Neither

65%

45%

Subtracted Funds

8% 11%

Added Funds

47%

24%

$1 BN

Hedge Fud Perormace Fee Structure (2010)


Other

12%7%

20%

85% 82%

Less than 20%

8% 7%

$1 BN

$1 Billio+ Hedge Fud Maagemet Fee Structure (2010)


Other

16%

2.0%

38%

1.5%

34%

1.0%

9%

0.5%

3%


26/32


When looking to 2011, CIG: Institutional Survey 2011

respondents said that they expect three types o trends to

develop. The rst are changes that investors themselves

expect to drive. In all, 79% o our respondents expect to see

increased transparency in the coming year, with 58% predicting

more due diligence on investors in a und. Institutions were

sanguine about their ability to cause signicant change to the

terms o their broader relationships with hedge unds, but

primarily with the smaller ones. Over 90% stated that they

did not see longer lock-ups as likely to happen, and 53%

expected ees to decrease. However, investors were

demonstrably unsuccessul in extracting term and ee changes

rom the large, top perorming hedge unds where they were

allocating the overwhelming majority o capital. Moreover,

in ollow-up conversations with responding investors, we ound

that they seemed to be happy to pay or perormance and make

concessions on terms i the manager actually delivered. Overall,

our respondents conrmed that they elt they could rebalance

the terms o their relationships with hedge unds, but only

where the managers were new, small or underperorming.

Responding investors also expect to see changes that come

about as indirect eects o their actions. More than hal

said that they expect to see increased consolidation in

the hedge und segment. Nearly 70% o our respondents

anticipate hedge und leverage to increase or stay at current

levels. Throughout much o 2010, hedge und indexes were

highly correlated with major equity market indexes. We

believed then that investors seeking superior risk-adjusted

returns and diversication would, at some point, begin to

pressure their managers to act with more conviction. That

appears to be happening now, and we believe that theconcomitant uptick in the leverage o J.P. Morgans Prime

Brokerage clients is a good indicator.

The nal type o change that responding investors think will

be seen in 2011 is regulatory. Overall, 86% o our respondents

said that they expect increased regulation over hedge

unds. Investors that we spoke with separately on this topic

indicated that regulatory changes were likely to be generally

complementary to the trends that investors hoped to drive.

They also stated that they have little ability to predict what

these changes may be at any detailed level.

Hedge Fud Treds or 2011


86%

79%

53%

52%

37%

31%

26%

7%

58%

Increased Regulation

Increased Transparency

More Due Diligence on Investors in a Fund

Lower Fees

Consolidation

More Money Allocated to Managed Accounts

Decreased Leverage

More Money Allocated to UCITS

Longer Lock-Ups

0% 20% 40% 60% 80% 100%

V. Looking Ahead


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This years research was conducted over the course o the

ourth quarter o 2010 and rst quarter o 2011. When

constructing the respondent universe, we ocused on investor

quality and demographics (i.e., investor type, location and

years o experience). Our goal was to acilitate the assembly

o a orum or a balanced group o thought leaders. We

were ortunate to be able to involve many o the worlds

leading institutions in this eort. At the time o the survey,

the respondents had placed $0.7 trillion into the hedge und

segment. The respondents were geographically diverse, with

24% coming rom Europe, 17% rom Asia and 56% rom

Canada and the United States. Geographic segmentation

proved to be important in evaluating the surveys results, as

investors in dierent regions expressed divergent views on a

number o important topics.

Survey participants also represent a mix o levels o experience

in, and exposure to, hedge und investing. In all, 88% o

respondent assets invested in hedge unds were controlled by

investors who reported at least seven years o experience in

the space. We included a signicant number o investors who

were newer to hedge unds. These respondents were identied

using the same quality and demographic screens as the more

experienced investors who had placed the lions share o the

capital into hedge unds at the time o the survey.

The perspectives o the newcomers proved to be important,

as they represent the largest source o potential capital

inows and oten had views that diered rom those o

more experienced responding investors on several important

points. Approximately 40% o respondents disclosed they had

more than $1 billion invested in hedge unds at the time o

the survey. The remaining 60% consists o investors rom a

broad spectrum o placement sizes and includes responses

rom several high quality investors with very little, but high

potential, exposure to hedge unds.

Respodet Base (2010, based o umber o respodets)

Source: J.P. Morgan Capital Introduct ion Group: Institut ional Investor Survey, 2011 Figure 50

Middle East andLatin America 3%

Asia 17%

Europe 24%

North America 56%

Insurance Co. 3%

Consultant 5%

Other 6%

Wealth Mgmt. 6%

Bank 7%

Endowment, Foundation

and Pension 10%

Family Oce 19%

Fund of Funds 44%

Geographic LocationInvestor Types

Hedge Fud Ivestig Experiece

(2010, based o AUM i Hedge Fuds)


Less than 1 year 1%

13 years 9%

46 years 17%

710 years 22%

Greater than 10 years 51%

Overview o the J.P. Morgan CIG: Institutional Investor Survey, 2011


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24| Prime Brokerage

Notes:


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Notes:


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26| Prime Brokerage

Notes:


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IMPORTANT DISCLAIMER

These materials (Materials) have been prepared by J.P. Morgans Prime Brokerage business (JPM PB) or inormational purposes only. No research department within J.P. Morgan Chase & Co.

was involved in the preparation o or data collected or these Materials. Primarily, these Materials are intended to serve as JPM PBs analysis o survey responses collec ted by J.P. Morgans PrimeServices Capital Introduction Group (CIG) rom institutional hedge und investors that par ticipate in J.P. Morgans Prime Services Capital Introduction Program (the CIG Program). The number o

institutional hedge und investors represented in thes e Materials is smaller relative to the size o the institutional hedge und investor marketplace, and these Materials are not intended to represent

the views o the institutional hedge und investor community at large. Although these Materials are derived rom sources believed to be reliable, these Materials have not been veriied or accuracy

or completeness by J.P. Morgan Chase & Co. or by any o its subsidiaries, their respective ailiates, successors, assigns, agents , or by any o their respective oicers, directors, employees, a gents or

advisers (collectively, J.P. Morgan), and J.P. Morgan does not guaranty the se Materials in any respect, including but not limited to, their accuracy, completeness or timeliness. Inormation or these

Materials was collected and compiled during the s tated timerame. J.P. Morgan has no obligation to update any portion o t hese Materials. Past perormance is n ot a guarantee o uture results.

These Materials may not be relied upon as deinitive, and shall not orm the basis o any decisions contemplated thereby. It is the users responsibility to independently conirm the inormation

presented in these Materials, and to obtain any other inormation deemed relevant to any decision made in connection with the subject matter contained in these Materials. J.P. Morgan makes no

representations (and to the extent permitted by law, all implied warranties and representations are hereby excluded), and J.P. Morgan takes no responsibility or the inormation presented in these

Materials. These Materials are provided or the intended users use only, and no portion o these Materials may be reproduced or distributed or any purpose wit hout the express written permission

o J.P. Morgan. None o the inormation presented in these Materials shall constitute, or be construed as constituting or be deemed to constitute an o er to buy or sell or a solicitation o an oer

to buy or sell any securities.

The CIG Program operates through J.P. Morgan Clearing Corp., J.P. Morgan Securities Ltd, J.P. Morgan Markets Limited, J.P. Morgan Chase Bank N.A., Singapore Branch (JPMSB), J.P. Morgan

Securities (Asia Paciic) Limited (JPMSAPL) and J.P. Morgan Securities Japan Co., Ltd. (JPMSJ). J.P. Morgan does not charge or receive ees or introduc tion services provided t hrough the CIG

Program. The CIG Program does not provide capital raising, placement agent, reerral, solicitation or equivalent services (Placement Services) to unds, their related investment managers,

general partners, managing members or their equivalent s that participate in the CIG Program (Manager Participants). The CIG Program also does not provide investment recommendations or

endorsements o any kind (Advisory Services) to eligible prospective institutional investors participating in the CIG Program (Investor Participants), including in relation to Manager Participants,

recommendations or endorsements o their services, products, investments or investment strategies. Placement Services and Advisory Services may, however, be provided by J.P. Morganbusinesses unrelated to the CIG Program. Inormation presented in connection with the CIG Program may not be suitable or any and all institutions. Under all applicable laws, including but not

limited to, the U.S. Employee Retirement Income Security Act o 1974, as amended, or the U.S. Internal Revenue Code o 1986, none o the inormation presented in connection with th e CIG Program

shall constitute, or be construed as cons tituting or be deemed to constitute investment advice, and J.P. Morgan is not acting as iduciary or any purpose.

An investment in a hedge und is speculative and involves a high degree o risk, which each investor must careully consider. Returns generated rom an investment in a hedge und may not

adequately compensate investors or the business and inancial risks assumed. An investor in hedge unds could lose all or a substantial amount o his or her investment . While hedge unds are

subject to market risks common to other types o investments, including market volatility, hedge unds employ certain trading techniques, such as the use o leveraging and other speculative

investment practices that may increase the risk o investment loss. Other risks a ssociated with hedge und investments include, but are not limited to, the act that hedge unds: can be highly illiquid;

are not required to provide periodic pricing or valuation inormation to investors; may involve complex t ax structures and delays in distributing important tax inormation; are not subject to the

same regulatory requirements as mutual unds; oten charge higher ees and the high ees may oset the unds trading proits; may have a limited operating history; can have perormance that

is volatile; may have a und manager who has total trading authority over the und and t he use o a single adviser applying generally similar trading programs could mean a lack o diversiication,

and consequentially, higher risk; may not have a secondary market or an investors interest in t he und and none may be expec ted to develop; may have restrictions on trans erring interests in the

und; and may aect a substantial port ion o its trades on oreign exchanges.

2011 JPMorgan Chase & Co. All rights reserved. J.P. Morgan is a marketing name or the prime brokerage business o JP Morgan Chase & Co. and its subsidiaries worldwide. Clearing and custody

services are provided by J.P. Morgan Clearing Corp. (JPMCC) and J.P. Morgan Securities Ltd (JPMSL). Access to inancial product s and execution ser vices is oered through J.P. Morgan Securities

LLC (JPMS). JPMCC and JPMS are each separately registered broker dealer ailiates o JP M organ Chase & Co., and are each members o FINRA, NYSE and SIPC. JPMSL and J.P. Morgan Markets

Limited are authorized and regulated by the FSA. JPMSAPL is licensed and regulated by the Securities and Futures Commission o Hong Kong. JPMSB is regulated by the Monetary Authority o

Singapore. JPMSJ is registered and regulated by the Financial Services Authority in Japan. All o the oregoing entities are subsidiaries or ailiates o JPMorgan Chase & Co. and are included in the

JPMorgan amily o companies. Product names, company names, and logos mentioned herein are trademarks or registered trademarks o their respective owners.


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